Average Directional Index (ADX) - The Complete Guide

Table of Contents

Average Directional Index (ADX) is a commonly used technical indicator to measure the strength of the current trend of the price action. Here we will cover the concepts and application of ADX and how it gets complimented by directional components to also know the direction of the trend.. ADX stands for "Average Directional Index". ADX indicator was developed by J. Welles Wilder. ADX helps us in determining if the price action has a trend, either bullish or bearish, of the price action is running in a sideway range. ADX, alone, does not indicate the direction of the trend and just measures the strength of the trend. The indication of the direction comes by two associated components which are known as "Positive Directional Index" (+DI) and "Negative Directional Index" (-DI).

Please note that the explanation here is focused on Forex trading but the same is equally valid for stocks of any commodity trading.

The three crisscrossing lines below the price action chart in the above screenshot represent the ADX indicator. As indicated, one line is the main ADX line and other two are +DI and -DI lines.

ADX is an oscillator which moves between a range of 0 to 100 but it rarely goes above 60. If ADX is above 25, it indicates an underlying trend. Any value below 25 indicates the lack of a trend. A rising ADX represents the rising momentum of the trend and a drop in the value indicates that the momentum of the trend is slowing down.

The crossover signals for market entry and exit are generated by the +DI and -DI lines' crossover.

1) +DI line moving upwards: When +DI line moves over -DI line, it indicates bullish sentiments and gives an signal for buying or exiting any short position which you might be holding.

2) +DI line moving downwards: When +DI line moves below -DI line, it indicates bearish sentiments and gives an signal for short-selling or to exit any already existing long position.

3) It is always better to consult ADX on longer time-frame charts say before taking a decision on shorter time-frame charts. Longer time-frame charts give us a broader picture of the longer term trend. In simple words the short term chart may indicate that the trend is weakening but a longer term chart may indicate that the drop is just a temporary correction and the trend still exists.

The final step is to calculate the moving average of the calculated DX (directional index), as mentioned above, for a selected number of periods for which we wish to use ADX Hence the Average Directional Movement Index is calculated as follows

ADX = The exponential moving average of DX and hence the formula is as follows:

ADX = SUM[{(+DI)-(-DI)}/{(+DI)+(-DI)}, N]/N

Where:

N = The number of periods used in the calculation e.g. 14 period on a hourly chart means 14 hours and 14 period on a daily chart means 14 days.

ADX Divergences:

ADX trading signals are also generated or by divergences.

When the subsequent highs and lows (peaks and valleys) of ADX line are going lower than the previous highs and lows, It indicates for an existing or emerging down trend. Similarly if the subsequent highs and lows are going higher than the previous ones, it is an indication that an uptrend is in place or is emerging.

Quick Links

Follow Us

Legal Disclaimer and Risk Disclosure: ForexAbode.com is an information site on the foreign exchange (Forex trading) market. Our analysis and forecasts only reflect our views. Any suggestion and Forex trading analysis or advice given on this website is based on our experience of the Forex market and does not constitute an investment advice. We will not accept any liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from the use of, or reliance on, such information anywhere on this site. This includes the in-house analysis or any contents posted by any other member of the site.